3.00% next week as economic activity improves

The Australian dollar continued to strengthen against is currency counterparts this week and is poised to mark its longest monthly winning streak since December 1989 as investors ramp up long-term expectations for higher borrowing in the $1T economy. Credit Suisse overnight index swaps are up 191bp in August after the Reserve Bank of Australia curbed speculation for further easing, and the interest rate outlook may continue to trend higher throughout the second half of the year as the central bank anticipates economic activity to expand at an annual rate of 0.5% this year. However, China’s State Council announced plans to limit new lending and restrict overcapacity in major industries including steel and cement after pledging to increase capital requirements for banks earlier this month, and policy makers may take further steps to ‘guide the healthy development of industries’ as the economy stands at a ‘critical period.’ The shift in government policy spurred fears of a slower global recovery as the world’s third largest economy looks to scale back on consumption, and fading demands from China, Australia’s biggest trading partner, is likely to hamper the outlook for future policy as the RBA maintains a cautious tone. At the same time, stocks in Asia/Pacific slumped throughout the week, with the Shanghai Composite index posting is fourth consecutive weekly decline, and the rise in risk aversion could temper the rally in the AUD/USD as investors weigh the outlook for a sustainable recovery. At the same time, aussie-dollar forex options have shown market sentiment has been extreme for some time, and suggests a major pull back is underway as non-commercial futures traders remain net-long on the Australian dollar, and fears of a slower return to growth paired with the rise in risk aversion could weigh on the exchange rate in the month ahead.Nevertheless, a Bloomberg News survey shows all of the 17 economists polled forecast the Reserve Bank of Australia to hold the benchmark interest rate at the 49-year low of 3.00% next week as economic activity improves, and commentary following the rate decision may instill an enhanced outlook for future policy as the central bank is widely anticipated to maintain a neutral policy stance throughout the second-half of the year. Moreover, market participants project economic activity to expand for the second consecutive quarter, with economists forecasting the annual rate of growth to increase 0.7% from the previous year, and the data may drive the exchange rate higher as growth prospects improve. However, the trade deficit is projected to widen to 880M in July from -441M in the previous month, and the slump in global trade may weigh on the outlook for future growth as exports account for more than 20% of GDP. - DS